manag ing growth of microfinance institutions (mfis

62

ING GROWTH OF MICROFINANCE

SU

2

stract

icrofinance ing capable and

Ethiopiand 20 volume of loan portfolio and savings increased by 263%,

sustain ncreased their

of the the 13 treach, 9 showed a remarkable

mainta eir portfolio quality.

on

Ethiopia. The ase the growth and sustainability of MFIs include: (a) Improving the institutional capacity of the MFIs by the implementing an efficient organizational structure, (changes in organization culture, structure and systems, for instance, decentralized lending decisions) with appropriate staff incentive and reward system, improvement of the skill of human resource, good governance, introduction of innovative financial products, and the increase of geographic expansion; (b) creating an enabling legal, regulatory and policy environment; (c) improve access to capital; (d) selective government and donor support; and (e) improving the demand side of the equation.

MANAGINSTITUTIONS (MFIS): BALANCING STAINABILITY AND REACHING LARGE NUMBER OF CLIENTS IN ETHIOPIA1

By Wolday Amha

Ab

The overriding objective of MFIs in Ethiopia is to provide a broad range of m by developservices to large numbers of poor households. This is realized

sustainable MFIs. A large number of MFIs have achieved significant progress in terms of both outreach and sustainability. As of June 2005, the twenty six deposit taking MFIs had

ve loan portfolio of about 1.5 billion Birr an acti (173 million USD) delivered to 1,211,305 active clients. They mobilized about 501million Birr (58 million US dollars) in savings. The

an MFIs attained such a significant outreach in a brief period of time. Between 2001 05, the number of clients,

479%, and 206%, respectively. In 2004, 12 out of the 15 MFIs were operationally able, while 5 were financially sustainable. The majority of the MFIs i

efficiency and productivity indicators as a result of expansion or increase in outreach. Out 15 MFIs, eleven had less than 5% portfolio at risk, which was encouraging. Out of MFIs which registered significant growth in ou

decline in their portfolio at risk. As a result of the increased outreach, many of the MFIs ined and some improved th

A careful balancing of increasing outreach and sustainability; with a parallel focusinstitutional capacity; reducing costs and risks; and improving efficiency, profitability and portfolio quality, is needed to address the financial demand millions of unbanked people in

specific interventions to incre

cle was submitted in November 2006

Director of the Association of Ethiopian Microfinance Institutions (AEMFI) I would like to thank Mr. Tsegaye Anebo (Financial Analyst of the Association of Ethiopian Microfinance stitutions) and Dr. Tekie Alemu (Economics Department, AAU) for their professional input

1 The final version of this arti2 **In

Ethiopian Journal of Economics, Volume XIII, No 2, October 2004

63

. Introduction 1.1 Background Poverty in Ethiopia is a manifestation of complex factors such as high population growth, environmental degradation, high unemployment, drought, low level of literacy, limited access to resources, health and education services, etc. Since poverty in Ethiopia is a national crisis caused by multi-dimensional problems involving multiplicity of actors, there is no single guaranteed approach to its eradication. The solutions to poverty are as multifaceted as its causes.

Addressing poverty has been the subject of many development programs in Ethiopia. Delivering financial services to poor households, by increasing employment, income, consumption and empowerment of disadvantaged groups, has been viewed as one of the antipoverty tools of development programs. Improving financial access to the poor also facilitates economic growth by easing liquidity constraints, and providing capital to startup new production related activities or adopt new technologies. Yet, microfinance is not a panacea for poverty and related development challenges. Microfinance alone cannot improve roads, housing, water supply, education, and health services. However, it can play an important role in making the above interventions be more fruitful. It is a means to empower and build the confidence and self-esteem of the poor and the disadvantaged groups. In order to provide microfinance services to poor households through sustainable microfinance institutions (MFIs), the government of Ethiopia issued its first microfinance legislation in 1996. The main objective of the microfinance institutions is the delivery of micro-loans, micro-savings, micro-insurance, money transfer, etc to large number of productive but resource-poor people in rural and urban areas, including micro and small entrepreneurs in a cost-effective and sustainable way. At the end of the day, the interventions of MFIs should contribute to positive and measurable impacts on the wellbeing of millions of households in Ethiopia. Thus, increasing the outreach in the delivery of financial services is very critical for Ethiopian MFIs in their effort of reducing poverty, ensuring food security and contributing to economic growth. Delivering microfinance services to large number of households would not be sustainable unless the microfinance institutions adhere to sustainability, efficiency and productivity objectives. Although the Ethiopian MFIs have increased their outreach, efficiency, sustainability and improved portfolio quality in a short span of time, the relationship between the growth in outreach and performance indicators of

1

Wolday Amha: Managing growth of microfinance institutions:…

64

MFIs dly such to fill the gap outr 1.2 O The objectives of the study are to: 1) Assess the performance o of the growth of outreach; 2) Study the relationship between growth of outreach of MFIs and the performance

indicators (financial, efficiency, and prod3) Examine the factors that affect s; and ) Identify the interventions required to manage growth of outreach.

1.3 This pia are nd imp pid exp nd cos ine gro ity, sus h? 1.4 The he Ass ary info 1.5 The ual fram in Eth nd fina ility, efficiency and portfolio quality indicators. Section five presents

wth of outreach of MFIs. Section six concludes by olicy implications and

need to be properly studied. To the knowledge of the author, there are har studies which examined the above relationships. The objective of this study is

in research and study the relationship and factors that affect growth ofeach and performance variables in the Ethiopian MFIs.

bjectives

f the MFIs in Ethiopia in terms

uctivity) indicators growth of MFI

4

Research questions

study attempts to respond to the following key questions which MFIs in Ethio confronted with in their effort of increasing outreach, efficiency, productivity, arove portfolio quality. These include: (i) What are the challenges of raansion of MFIs in Ethiopia? (ii) Is rapid growth an illusion, unsustainable atly to MFIs? (iii) Do MFIs need expansion? (iv) What are the factors that determwth of MFIs? (v) What is the relationship between growth, productivtainability, efficiency and portfolio quality? And (vi) How do MFIs manage growt

Data

data set for this study is collected from the Performance Monitoring Unit of tociation of Ethiopian Microfinance Institutions (AEMFI); and secondrmation collected from various research reports and surveys.

Organization of the paper

paper is organized in six sections. Section two describes the conceptework. Section three reviews the development of the microfinance industry

iopia. Section four analyses the relationship between growth of outreach ancial viab

factors affecting the grommarizing the main findings of the studsu y, p

recommendations.


65

ework

inance is one of the key elements in addressing development issues. It is even considered

ding them and the stitutions involved in this process (Krahnen and Schmidt, 1994). If the objective is to

ers (Krahnen nd Schmidt, 1994).

inable and capable financial stitutions that can mobilize savings and at the same time provide loans to urban and

st recognize that theory has shaped policies to a uch larger extent in this field than in many other fields of development. According to

2. Conceptual fram Fto play a leading role in guiding development interventions. Whatever development strategies or programs (poverty reduction strategy, rural development strategy, industrial development strategy, food security strategy, etc.,), we may propose for Ethiopia, there will always be a need for finance and financial systems to implement them. The provision of finance contains two basic elements: (i) capital, the funds which are being provided; and (ii) financial system, the process of proviindeliver financial services to rural and urban households, we need to have both the capital, and well-functioning financial systems and institutions. In order to increase outreach, efficiency and sustainability, MFIs3 require interventions at the level of the whole economy (such as the structural adjustment program), at the level of the financial sector (such as the financial sector reform), and interventions focused on individual financial institutions or, as the case may be, on their customa In the Ethiopian context, at least in the short-run, there are banks with excess liquidity. Currently, even if the minimum saving interest rate declined from 6% to 3% in the last three years, the saving deposits of banks increased significantly. To convert these savings into investment, we need sustainrural households. 2.1 Historical development of finance and development The objective of this section is to review the development of finance and development, with particular emphasis on the delivery of financial services to the unbanked. The review of the historical development of finance and development will provide useful information on how to increase growth of outreach using sustainable financial systems and institutions. Starting with theoretical concept might be irrelevant for practitioners. However, we mumKrahnen and Schmidt (1994), there are four views on the role of finance for development.

3 Financial institutions, in the broader sense include all actual providers of financial services and the interactions with their customers.


66

ance is explained as part f growth theory and capital. Finance is the determinant of growth. Moreover,

de e result of a vicious circle of poverty, i.e., poor people are oor because their income is so low that they cannot save, and thus can not invest.

ant for growth (which could be generated through al g

savin ent local savings and e veloping countries will bring

at a policy of rgeted investment in large-scale industry and infrastructure would in the final

sis and socially balanced process of economic se that summed up the essence of this

growth theory (trickle down approach), particularly the impact of the fusion of capital into big development projects on increasing income of poor

such as commercial rmers, smallholder farmers, small entrepreneurs, etc. The basic understanding of

e e recipients changed (farmers and small usinesses instead of big business and public institutions). Finance was viewed as just

ups. There were also attempts to identify new institutions such as

(i) Traditional approach (50s-60s) According to the traditional approach, investment is a necessary prerequisite for growth that requires the availability of capital. The role of finounder velopment is thpNo doubt that investment is importloc or foreign saving mobilization), the issue lies on the mechanism of transforminsavings into investment (collecting and allocating savings). However, local income,

g and investment is low, thus foreign savings have to augmclos the “saving gap”. The real-asset transfers to the depositive linkage effects. Underlying this approach was the notion thtaanaly lead to a broad-based

ent: ‘trickle-down” was the phradevelopmpolicy, which included the provision of loans at low interest rates with long maturities as a core element. This has been a complete failure. Contrary to the expectations of the time, the injection of external capital had exacerbated the existing social and economic inequalities and led to widespread poverty instead of socially balanced growth (Schmidt and Zeitinger, 1996). (ii) Target-group-oriented approach (era of specialized development banks)

(60s-80s) In the 70s, the inhouseholds were questioned. There was a change towards worldwide social policy aiming at income generation, poverty alleviation, employment creation and similar objectives. The new approach focused on specific target groups fafinanc remained the same as before, only thbproviding credit and the financial system did not matter for development. However, this approach provided better attention to finance in the sense of financial systems development. Development planners were looking for methods of distributing credit to poor farmers, small businesses, etc. This led to the development of institutions such as specialized development banks in Africa, Asia and Latin America. However, development banks proved to be costly (needed huge subsidy), unprofitable, inefficient and failed to reach the target gro


67

s a w methods as group financing, but the xperiments were only a drop in the bucket.

ssence of a

nd incentives (80s-90s)

on information and incentive problems in the development of cia

rmers. Such schemes were characterized by over emphasis on outreach and heavily subsidized lending interest rates. Saving products for the poor and sustainability of the institutions were entirely ignored. The results of these

ly the

NGO nd cooperatives which started using nee (iii) Financial systems development (70s-80s) The approach advocates that the financial systems of developing countries is misused and repressed (policy of financial repression) which need to be liberalized

nd strengthened. It focused on financial intermediation which is the eafinancial system. The three main propositions of the advocates of this approach included:

(a) The quantity and quality of financial intermediation that is available in a given society is a very important determinant of development,

(b) The quantity and quality of financial intermediation is determined nearly exclusively by the economic policies pursued by respective governments and

(c) The best policy is a policy of drastic deregulation of financial system.

v) Finance, institutions a(i This approach holds that economic development depends more on the availability of efficient institutions than on anything else, and the most important institutional prerequisite is the existence of sustainable and capable financial sector. Although the third approach rightly stressed on the importance of the financial markets, a financial system which is not repressed would not, by itself, function optimally. This particular

pproach focused afinan l sector (Stigiltz 1989). 2.2 Paradigm shift in the delivery of financial services to the

poor In the last 20 years, there is a growing worldwide understanding on how microfinance institutions could deliver financial services to large number of households in a sustainable way. As indicated earlier, there had been an emphasis on rural credit schemes through government projects, development banks, cooperatives and NGOs, aimed at promoting agricultural production and increasing incomes among smallholder fa

interventions were very poor repayment rates and frequently low impact. Ironical


68

s ctive to the non-poor and more powerful and ometimes the original target groups were excluded.

rontier of the formal financial system. Notable uccess in creating sustainable microfinance institutions around the world has

icrofinance institutions consist of agents and organizations that engage in relatively

sub idy element was often highly attras The ‘microfinance revolution’ which emerged in the 1990s resulted in a significant paradigm shift focusing on the provision of financial services (loans, savings, insurance, money transfer, etc) on a sustainable basis. Contrary to the earlier assumption, there has been a growing awareness that the poor do not need subsidized credit. Rather what is required is sustained access to financial services. The origin of this change in paradigm can be traced to both the disillusionment with the subsidized rural credit model and a better understanding of the informal sector activities through which many of the rural and urban poor across developing countries derive their incomes. With low transaction costs, the marginal rates of return on capital in the informal finance are found to be extremely high. This implied that the major problem of poor households has been mainly availability of flexible financial services on a sustainable manner. Under the new paradigm, microfinance is based on creating sustainable institutions using innovative methodologies and systems which can deliver financial services efficiently, including the recovery of loans at low cost. It is through the creation of such institutions that the financial frontier can be pushed forward – reaching very large number of the poor beyond the fsconvincingly demonstrated the viability of expanding the frontier.

Msmall financial transactions using specialized, character-based methodologies to serve low-income households, micro enterprises, small farmers, and others who lack access to the banking system. Microfinance services may be delivered through informal, semi-formal (that is, legally registered but not under central bank regulation), or formal financial intermediaries. However, there is a need to incorporate microfinance activities into countries’ financial development strategies and financial system to expand the scope and raise the efficiency of financial intermediation, either directly intermediating by mobilizing deposits or on-lending or raising finance on a wholesale basis through financial markets. The intention is to ensure that access to financial services by rural households, micro entrepreneurs, women and disadvantaged groups improves sustainability over time.


69

enormous. For example, if we

mercial banks; ii) iii)

iv) v) Gvi) vii latives,

) in the Amhara Region have branch banks. Even if ara

urrently, with the exception of the indirect interventions in fertilizer and improved

3. Review of the development of microfinance services in Ethiopia

The potential demand for micro-credit in Ethiopia isassume that there are 15 million households in Ethiopia, targeting one person per household who require micro-credit and also assuming half of the households are able poor, then over 7.5 million active clients will require micro-credit. However, there is very limited supply of financial services to the poor households. The major sources of loans or financial services in Ethiopia are as follows:

i) ComMicrofinance institutions (MFIs);

Cooperatives (savings and credit cooperatives and multipurpose ooperatives); c

NGOs which are involved in the delivery of financial services; overnment projects and programs involved in providing loans;

Semi-formal finance (Iqqub, Iddir, Mahiber, etc.); and ) Informal finance (money lenders, traders, suppliers credit, friends, re

etc) The capacity of the conventional banking sector in Ethiopia has been too weak to serve the needs of the poor. The Commercial Bank of Ethiopia (CBE), Development Bank of Ethiopia (DBE) and Construction and Business Bank have only 174, 32 and 26 branches in the whole country, respectively. As of June 2005, the private banks together, had 162 branches. The newly established Cooperative Bank of Oromia had 5 branches. Most of the branches of the commercial banks are concentrated in urban areas. Many of the Woredas in Ethiopia do not have such services. For example, only 25% of the Woredas (districtsthere e banks in these Woredas, due to high collateral requirements (land or physic l assets), the poor have limited access to conventional banks.

Cseed credit, conventional banks in Ethiopia consider the poor as credit risks and unbankable. According to the discussions with the commercial banks in Ethiopia, a loan size below 100,000 Birr is not attractive and profitable. Thus, MFIs and savings and credit cooperatives should be designed to respond to the failure of the commercial and development banks to serve the financial needs of small farmers and MSE operators. The delivering financial services to the poor requires financial systems that reach the poor and an innovative targeting methodology and a credit delivery mechanism that helps identify and attract only the poor who can initiate and sustain productive use of loans.


70

utional credit that contributes to n increase in investment is very limited in the country. The majority of the poor get

he semi-formal lending institutions such as Iqqub (Rotating Savings and Credit

he other major financial services’ outlet is the savings and credit cooperatives and

been delivering relief and evelopment services such as emergency food, health, education, water, etc since e 1970s. In terms of the delivery of financial services to the poor, NGOs were irectly funding micro-credit activities as part and parcel of their poverty alleviation rograms. As the delivery of microfinance activities grew, the question of operational nd financial sustainability has been raised. Initially the NGOs in the country had

The poor in Ethiopia have low income that leads to low investment, which in turn leads to low productivity and income. Access to institaaccess to financial services through informal channels such as moneylenders, Iqqub, Iddir, friends, relatives, traders, etc. (Bezabih, et al 2005). The share of informal finance in terms of borrowers and loan size is estimated to reach 69 percent and 61 percent. respectively. Among the borrowers from the informal sources, 35 percent borrowed from friends and relatives, 48 percent from private lenders, 15 percent form Iddir and two percent from Iqqub. Only 3 percent of them borrowed from both relatives and other informal sources. Moreover, 10 percent of the borrowers borrowed from multiple informal financial sources. The informal lenders are able to enforce loan contracts, have high loan recovery rates and flexible loan terms. However, the interest rates are very high and the government, through the support of cooperatives and MFIs, is making efforts to curb their roles. TAssociations), Iddir, Mahber, etc are the dominant and sustainable traditional institutions that meet the financial and social needs of the poor. Iqqub which is popular both in urban and rural areas is the dominant form of savings and credit associations in Ethiopia. It is not a permanent club; it could be continued or dissolved after its members have each a turn. A member can attend Iqqub meeting weekly, or bi-weekly, or monthly to collect fixed sum of payments. Tmulti-purpose cooperatives. According to the information of the Federal Cooperative Commission, by the end of June 2004, there were 2,146 savings and credit cooperatives (1,854 urban and 292 rural) with 155,120 members, 8,233,002 Birr of equity/share capital and mobilized 496,101,082 Birr of savings. They have a total asset of 530,587,219 Birr and an outstanding loan of 7,352,782 Birr. Although there was a continuous increase in the number of savings and credit cooperatives and members, rural areas are relatively excluded. About 86% of the savings and credit cooperative members were employees with fixed monthly salary and urban-based. Moreover, about 29% of the registered savings and credit cooperative members in the country were situated in Addis Ababa. NGO and donor funded projects in Ethiopia have dthdpa


71

an tes n their development programs. However, the GO in , before the issuance of the microfinance

a)

r g sustainable in .

b) u h subsidized

annu f inflation) in these programs were negative. As a result, the loans

ancial services

in 1996 were not real financial intermediaries, but

positive impact in developing flexible methodologies that fit the needs of beneficiaries d ted various innovative ideas i

itiated micro-credit programsNlegislation, faced several problems of mixing social and financial objectives. The ACDI/CEE study (1995) revealed that financial schemes of NGOs and institutions that do not follow sound and sustainable financial principles might cause more harm than good because they do not encourage financially responsible behavior. The micro-credit initiatives before the issuance of the microfinance leg lowing features: islation (pre 1996) had the fol

The entire orientations of the micro-credit initiatives or activities in Ethiopia (pre 1996) were geared towards a project concept. The NGOs involved in micro-credit p ograms and government projects were not interested in establishinf ancial institutions that deliver diversified financial services to the poor

1996), witS bsidized NGOs’ micro-credit programs in Ethiopia (prelending interest rates, and created a problem in building sustainable financial institutions. The real interest rates (the actual interest rates deflated by the

al rate owere gifts instead of loans that should be strictly repaid regularly. The micro-credit programs were not able to cover their operational costs and required permanent and heavy subsidy.

c) The very high default rates faced commercial banks, NGOs and government projects were mainly the result of borrowers seeing the lending organizations as donor or government funded projects that provided financial services for a fixed period of time for humanitarian reasons.

d) The lending institutions and employees were not seriously committed and did not enforce financial discipline, provided donor funds kept on flowing.

e) The micro-credit programs focused entirely on the provision of loans to beneficiaries. Saving products were forgotten in the delivery of finto the poor. Policy makers, development experts, researchers from academics, including practitioners, believed that poor people are too poor to save and are unbankable. Savings were not considered as sources of loanable capital. Donors were considered as the only source of loan fund, which encouraged dependency. The low lending interest rates were also discouraging the saving products of the institutions. As a result, the micro-credit programs in Ethiopia were unsustainable and failed to promote saving culture.

The Agricultural and Industrial Development Bank (AIDB), NGOs and cooperatives which delivered financial services to the urban and rural poor before the issuance of regulatory microfinance legislation


72

sustainable financial service delivery ystem followed by mobilizing savings; charging market interest rates on loans

ions in Ethiopia necessitated a

gulatory framework. This need brought the activities of the MFIs under Ethiopia’s

d urban households through sustainable nancial institutions in Ethiopia has been based on the best practices around the

rather tools of distributing donor or government funds to a target population in order to increase agricultural production and productivity. The study of ACDI/CEE (1995) recommended that the government should develop national standards for NGO credit schemes or programs. Another study by Pischke et al. (1996) also recommended that NGOs offering credit and other financial services should be subject to national standards, and that the adoption of appropriate standards could improve their performance.

Given the above problems of AIDB, NGOs and the collapse of the service cooperatives in Ethiopia, it was time for the policy makers and individuals involved in development activities to rethink and redesign new strategies for the delivery of financial services to poor households through sustainable financial institutions. This required a redefinition and reorientation of the mission, vision and objectives of the lending institutions that usually provided only micro-credit services. The most important change in direction was building a ssufficient to cover operational costs; applying strict financial discipline through strict loan recovery procedures; developing proper lending methodologies; reducing transaction costs and increasing outreach. The experiences of some sustainable microfinance institutions in Asia, Latin America, and Africa were also useful in directing the changes in the delivery of financial services to the poor in Ethiopia.

The need to promote more sustainable microfinance institutremonetary and financial policy framework. Proclamation No. 40/1996 indicates the requirements of licensing microfinance institutions by empowering the NBE to take charge of this and supervising them (see Wolday Amha, 2005 for the details). There are currently 26 microfinance institutions registered under the NBE. Although illegal as per the law of the country, some NGOs, donors and government departments, still deliver financial services to the poor through various projects and programs which distort the markets. A good example is the micro-credit program which promotes micro-enterprises through the regional trade and industry bureaus. Delivering financial services to the rural anfiworld. Some of the key elements or factors which are required in establishing sustainable and efficient microfinance institutions include increasing outreach, operational and financial sustainability, development of demand driven financial products, institutional capacity and the capacity to mobilize resources. These are discussed in the following sections.


73

its target

h rowth of

t increase in the size, scale, and omplexity in activities and the various results being achieved by MFIs overtime. This

usa

meanbeco capacity of

Growand planninstit

•

•

•••

•

Growit is w

•dit monitoring;

• mismatch between organizational and skill capacity and rapid expansion;

4. The relationship between growth of outreach and financial and productivity indicators of the Ethiopian microfinance institutions

Outreach measures the extent to which an MFI has succeeded in reachingclients and met the demand of clients for financial services (Yaron, 1992). The scaleof outreach is the number of clients reached by MFIs, while the depth of outreacgives the type of clients and the level of poverty of the clients reached. Goutreach of the MFIs involves: (i) a permanencincl des increases in number of clients, outstanding loan portfolio and turnover, size of vings, etc. (ii) the changes in character of the finance providers. This would

the transformation of the institution (graduation of a financial provider to me a regulated financial organization), improving and upgrading the

an institution and obtaining improved levels of sustainability.

th of outreach is desirable as it would reduce poverty and attain its operational financial sustainability MFIs. Although growth of outreach has risks (unless ed and managed very well), it has also positive implications for financial

utions. In general growth in outreach

enables the MFIs to reach large number of clients and it is the key to make sound impact on reducing poverty,

reduces average operating cost of MFIs by reducing/eliminating losses, and not by increasing lending interest rates;

improves operational and financial sustainability. helps MFIs to satisfy their client’s need through various services. gives better image of MFIs to attract loanable fund from banks for their

expansion; and increases the borrower’s willingness to repay.

th in outreach is one of the prime objectives of Ethiopian MFIs. However, unless ell organized and planned, rapid growth may have negative implications such as

increase in loan arrears due to rapid growth in new borrowers, who are more risky than well-established borrowers and difficulties in cre

• decline in portfolio quality • incompatibility between the objective of reaching the poorest and increasing

the number of clients.


74

loan), loan size, number of saving clients, volume of savings, percentage of loans to

es to 20,000 to 50,000 clients. These are MFIs that are growing and with the right support, they

Bank of Ethiopia ad an active loan portfolio of about 1.5 billion Birr (173 million USD) delivered to

), hich reveals that MFIs in Ethiopia focus on the active poor. The MFIs have attained

Moreover, the scattered settlement of the rural households and the problem of accessing them for communication have negative effect on growth. 4.1 Growth of outreach of Ethiopian MFIs Outreach is measured in terms of the number of active clients (with outstanding

clientele below poverty line, percentage of female clients, range of financial and non-financial services offered to the poor, the level of transaction costs levied on the poor and the extent of client satisfaction with respect to financial services. In the last ten years, the MFIs in Ethiopia have shown a remarkable progress in terms of outreach and performance. However, the twenty six MFIs meet only less than 20 percent of the demand for financial services of the active poor. This indicates that there is significant unmet potential demand for microfinance services in Ethiopia. ] Currently, some of the MFIs are at the startup stage where their clients are less than five thousand and require sound support to build their capacity so that they can increase their client base. There are also emerging MFIs with clients between 5,000 and 20,000, where their emphasis is on consolidating their activities to improve the quality of portfolio, performance and increase outreach. There are also MFIs that deliver financial servic

could become mature and sustainable MFIs. Mature sustainable MFIs, in the Ethiopian context, would typically have more than 50,000 clients. Four of the largest MFIs in Ethiopia are in this category (see the details in Annex 16). As of June 2005, the twenty six MFIs registered under the Nationalh1,211,305 active clients (Figure 1). This does not include the loans delivered to purchase fertilizer and improved seeds by the two largest MFIs. They also mobilized about 501million Birr (58 million US dollars) of savings (Annex 16). The clientele served by the MFIs in Ethiopia are mainly the rural poor. About 38 percent of the clients of the MFIs are female. The average loan size is about 1000 Birr (116 USDwsignificant growth in outreach in a brief period of time. Between 2001 and 2005, the number clients, volume of loan portfolio and savings increased by 263%, 479%, and 206%, respectively (Figure 1 and 2)


75

igure 2: Value of loan portfolio and savings of the 21 MFIs in Ethiopia, 2001-2005.

Figure 1: Number of clients in the 21 MFIs in Ethiopia, 2001-2005

F

-

200,000,000

400,000,000

600,000,000

800,000,000

1,000,000,000

1,200,000,000

1,400,000,000

1,600,000,000

2001 2003 2004 2005

PortfolioSavings

461,326

755,073

1,001,565

1,214,104

200,000

400,000

600,000

800,000

1,000,000

1,200,000

-

1,400,000

2001 ,2003 ,2004 , 2005

No of loan Client


76

Is in Ethiopia are latively lower than in other Sub-Saharan countries. In fact, the lending interest rates

me operation costs. This affects their ustainability negatively. The financial reports of some branches and sub-branches of

re allowed to mobilize

sustainability, productivity and portfolio quality

own. This implies that the growth in outreach of FIs should be examined against profitability, efficiency, productivity, and portfolio

ustainability, which shows the ability of the MFIs to cover their total expenses from their own financial service operations, has not been a major objective of MFIs in

The lending interest rate of MFIs in Ethiopia varies between 9 percent per year- declining rate-to 24 percent-flat rate. The lending interest rates of MFreof so of the MFIs are so low to cover theirsMFIs reveal that they are operationally sustainable. These sustainable branches and sub-branches even question why they should subsidize unprofitable branches and sub-branches of an MFI, which is normal in the Ethiopian MFIs. It is clear that MFIs that focus on poverty reduction and targeting the rural poor do have high operational costs that reduce their profit margin. This issue has emerged as one of the challenges of the MFIs in Ethiopia. It must be noted that the financial sustainability objective of MFIs complements the social objectives.

Ethiopia has a clear regulatory framework where the MFIs asavings starting from day one of their registration or after receiving their license from the National Bank of Ethiopia. The experience of Ethiopian MFIs in mobilizing savings is encouraging. As of June 2005, gross savings as percentage of the loan outstanding was about 33 percent. Another indicator of good performance of MFIs is the high repayment rates which varied from 85 to 100 percent. The average repayment rate of MFIs is 96 percent. There is a reasonable client/loan portfolio to field staff ratio, however this varies from one MFI to another (see annex 1-15). 4.2 Growth in outreach of MFIs vis-a-vis financial

indicators Although increasing the growth of outreach to reach large number of clients and make sound impact on poverty reduction is the overriding objective of MFIs in Ethiopia, it does not make sense if these institutions are unstable, unsustainable, unprofessional and inefficient. If an MFI is not sustainable due to its entire emphasis on social objectives, it will break down and foster unhealthy messages to the entire microfinance industry and distort the financial market. Poor people will learn that it is foolish to repay a loan, and they will be hesitant to deposit their savings in such institutions (Krahnen and Schmidt, 1994). Thus, an MFI must be structured and run in such a way that it can survive on its Mquality. S


77

FIs in Ethiopia

able (Annex 1-15), while 5 out of the 15 were financially sustainable. It is safe to conclude that MFIs in Ethiopia are in transition from subsidized overty reduction lending to commercially oriented lending. On top of the financial and

operational sustainability, we need to consider institutional sustainability which includes efficiency of service delivery, capacity to manage qualified, motivated and innovative staff, good governance, in-built efficient systems, etc. Table 1: Growth of outreach and sustainability, 2003 - 2004

% Change in outreach % Sustainability

Ethiopia at the initial stage. However, currently, a large number of Mhwere operationally sustainave achieved significant progress in terms of sustainability. In 2004, 12 out of 15 MFIs

p

MFIs Number of active

borrowers Gross loan

portfolio Savings balance

Operational self-

sufficiency

Financial self-

sufficiency Meklit 10% 38% 41% 24% -9% AVFS 69% 32% 63% -19% -3% Wasasa 140% 136% 155% 4% 9% Buusa -7% 0% 63% -4% -7% Eshet 48% 91% 85% 49% 48% Peace 43% 48% 62% 89% 78% Gasha 26% 109% 52% 19% 11%

Sidama -12% 10% 18% 45% 38% AdCSI 123% 369% 108% 21% -10% Wisdom 63% 60% 39% 30% 12% OMO 7% 28% 24% 20% 27% OCSSCO 40% 38% 46% 60% 47% ACSI 21% 49% 34% 30% 14% DECSI 49% 103% 17% 19% 31%

SFPI 19% 34% 10% -2% -2%

Source: AEMFI, 2005 Table 1 shows that MFIs in Ethiopia have been registering significant growth in outreach, in terms of number of active borrowers (ranging from -7% in Bussa MFI to 140% in Wasasa MFI), gross loan portfolio (from 0% in Bussa MFI to 369% in ADCSI) and mobilization of savings (17% in DECSI to 155% in Wasasa MFI). Most of the young MFIs grew quickly which is partly the result of the drive to get their operations to optimal size quickly, so that they can reap the benefits of economies of scale. The growth in outreach was accompanied by a significant increase in

self-sufficiency (12 out of the 15 MFIs) and financial self-sufficiency (10 operational


78

out of 15 MFIs). Thus, there was a substantial growth in outreach and improvement of operational and financial sustainability within one year (2003-2004). Table 2: Growth of outreach and efficiency 2003 - 2004

% Change in outreach % Change in efficiency


borrowers

Gross loan


Operating expense/ loan

portfolio

Personnel expense/ loan

portfolio Meklit 10% 38% 41% 7.70% -2.30% AVFS 69% 32% 63% -11% -12% Wasasa 140% 136% 155% 6% 10% Buusa -7% 0% 63% -5% 1% Eshet 48% 91% 85% -41% -39% Peace 43% 48% 62% -15% -12%

%

Gasha 26% 109% 52% -41% -43% SFPI 19% 34% 10% -15% -9% Sidama -12% 10% 18% -16% -15% AdCSI 123% 369% 108% -44% -41% Wisdom 63% 60% 39% -4% 12% OMO 7% 28% 24% 17% 17% OCSSCO 40% 38% 46% -16% -13% ACSI 21% 49% 34% -18% -20DECSI 49% 103% 17% -37% -38%

Source: AEMFI, 2005

cy measures the cost incurred by MFIs to carry out their financial services. io of operating e

EfficienThe rat xpense to loan portfolio indicates how much an MFI costs to eep 1 Birr of the portfolio out in the hands of clients (a declining ratio is an

Dedebit Credit and Saving Institution (2004). This could be partly explained y the group lending methodology applied almost in all MFIs. In the same year, the

kimprovement in efficiency). Since salary and salary related expenses represent a significant percentage of the operating costs of MFIs, a decrease in personnel expense to loan portfolio will have a positive impact on financial sustainability. As MFIs mature and adopt best practices in operational and financial management techniques, efficiency will increase. However, in the initial stages of a strong growth phase, efficiency can be expected to worsen as an MFI incurs new expenses, such as building offices, training cost and additional salary expenses. Ethiopian MFIs reach more clients at lower cost as is reflected by the ratio of operating expense to loan portfolio which varied from 41.8% in Bussa Gonoffa MFI to 3.8% in bpersonnel expense to loan portfolio varied from 21.9% in Bussa Gonoffa MFI to 2.3% in Dedebit it and Saving Institution (Annex 1-15). The results in Annex 1-15 indicate


79

% Change in outreach % Change in productivity

that the larger an MFI is in terms of outreach, the lower will be its efficiency ratio. Table 2 reveals that, with the exception of three MFIs, there were consistent declines in operating expense to loan portfolio ratio as a result of significant increase in outreach. Similar trend was observed in the personnel expense to loan portfolio ratio, that is, with the exception of four MFIs, the ratio declined as a result of increased outreach. Table 3: Growth of outreach and productivity 2003 - 2004

borrowe lance wers

smem

Borrowers n

Number of active Gross loan Savings Borro

per rs portfolio ba taff

ber per loaofficer

Meklit 10% 38% 41% -10% -17% AVFS

a 163% -11%

2 -14% 1 26%

1

m -18%

O 3

69%

32% 63% 35% 27% 29% Wasas 140% 136% 55% 24%

Buusa -7% Eshet

0% 91%

-17% 25% 48% 85% 3%

Peace 43% 48% 62% 8% Gasha 26% 09% 52% 21% SFPI 19% 34% 10% -2% -2% Sidama -12% 10% 18% -9% -8% AdCSI 123% 369% 08% 49% 41% Wisdo 63% 60% 39% 10% OMO OCSSC

7%40%

28%38%

24% 46%

1% 39%

1% 72%

ACSI 21% 49% 34% 8% 14% DECSI 49% 103% 17% 15% 36%

Source: AEMFI, 2005 A FI builds up taff and i ding exp e, the pr f its ing o s is likely to rapidly. an office te ogressive ger

re clients and larger loans, and overhead costs can be spread over larger portfolio for an MFI. In 2004, the ratio of borrower per loan officer varied from 214

s an M its s ts len erienc oductivity o lendperation grow Each lo r can adminis r a pr ly lar

loan portfolio with moain Gasha MFI to 518 in PEACE MFI. In the same year, the ratio of borrower per staff member varied from 89 in Sidama MFI to 388 in DECSI (Annex 1-15). Table 3 indicates that out of the 13 MFIs which showed significant increase in the number of clients, 9 of them registered significant increase in the ratio of borrower per loan officer. The majority of the MFIs increased their productivity indicators (borrower per staff and borrower per loan officer) as a result of expansion or increase in outreach.


80

e portfolio at risk easures the percentage of the adjusted outstanding gross loan portfolio that is at

ratio is the most accepted indicator of portfolio qua n of the po ted by arre d therefo risk of not being repaid. Best s the 30 days cut-of 004, at the a iWasasa MFIs to da An . Out MFIs, d less than 5% portfolio at risk, which was en ging. Ho the four ith la rtfolio at ris ld tak ediate s to redu portfolio to a able perc . Table 4 reveals that out of the 13 MFIs registe gnificant g in o showed remarkable ne in t ortfolio a The results reveal that, even though many MFIs ased o ch, they still maintained en improve their portf ality. However, given the same am f arrears, if an MFI in its loan ment significantly and writes-off its non-performi ns, t ld be an i ement portfo risk which not show eal picture of improvem in the y of its folio. Thu results regarding portfolio quality in Table 4 should be interpret h care. Table 4: Growth of ach and portfolio quality 2003 -

% Change in outreach % Change in portfolio quality

The critical question in the performance of MFIs is whether they will be able to significantly expand outreach and maintain the quality of portfolio. Thmrisk (a decreasing ratio is an improvement in quality). This

lity. It shows the portio rtfolio that is contaminaars an

f. In 2re at

the portfolio 26.2% in Si

practice useried from 0.1%

of the 15 risk of ma MFI (

15 MFIs vnex 1-15)

n PEACE and eleven ha

coura wever, MFIs wrge po k shou e imm action ce the at riskn accept entage

which red si rowthutreach, 9 decli heir p t risk.

incre utrea or evds

olio qu ount ocrease disburse

mng loa

here cou prov in the lio at might the rent qualit port s, the

ed wit

outre 2004


borrowers Gross loan


Portfolio at risk> 30 days

Write-off ratio

Meklit 10% 38% 41% 82% 18% AVFS 69% 32% 63% -80% -77% Wasasa 140% 136% 155% -98% 275% Buusa -7% 0% 63% -32% -62% Eshet 48% 91% 85% 80% Peace 43% 48% 62% -50% Gasha 26% 109% 52% -75% -25% SFPI 19% 34% 10% 66% 160% Sidama -12% 10% 18% -10% AdCSI 123% 369% 108% 164% -44% Wisdom 63% 60% 39% -34% -18% OMO 7% 28% 24% -51% -1% OCSSCO 40% 38% 46% -36% ACSI 21% 49% 34% -70% -31% DECSI 49% 103% 17% -62% -42%

Source: AEMFI, 2005


81

elated with the sustainability of clients of MFIs and donor support. The wth by relating them to

5.1 Institutional capac Is Institution building, being the key fa or grow FIs, is a ss whic es fro inimum rferenc modifi to far-r g mea to re e, transform build e ly new utions. are th sic el should nsidere uilding nable MF irstly, M ust be ntly orien wards t livery of cial services to the majority of th d househ Secon FIs must be viable over the medium-to-long term period. This incl the abili over th sts. If the to achie st-coverage, they must e prices e servic y provide h the cli an afford to pay and w s ient t r the full costs of run in . Thirdly, M hould be to keep costs – they wi on to their clients via the es they e them low as p le (Sch nd Ze 96).

jectiv s of in buildi to upgrad y reach large number of clients on a sustainable basis. This

kinds of financial

ce plays an important role in increasing outreach, improving transparency, accountability, sustainability, profitability, efficiency, effectiveness,

5. Factors affecting the growth or outreach of MFIs There are a number of factors that affect the growth of MFIs in Ethiopia. These include institutional capacity, availability of loanable funds, policy and regulatory environment, macro, meso and micro level economic performance, demand side

roblems rpfollowing section attempts to review the factors affecting grothe Ethiopian context.

ity of MF

ctor f th of M proce h rangm a m of inte e or cation eachin suresstructur and ntire instit There ree baements that be co d in b sustai Is: F FIs m permane ted to he de finan

e unbanke olds. dly, Mudes ty to c eir co y are ve co

charg for th es the whic ents chich are al o suffic o cove ning the

stitutions FIs s able their which ll pass pric charg - as ossib midt a

itinger, 19

One of the main obcrease their capacity and

e stitution ng is e MFIs so that theinhas two components, namely growth and qualitative transformation. It is important that MFIs grow rapidly in order to expand the scope of their operations and acquire expertise in lending, thus allowing them to reduce their costs to the extent that they become acceptable to pass them on, in full, to borrowers. Transformation partly refers to changes in the legal status of MFIs (say from an MFI to rural bank or from NGO to licensed depositing MFI), or changes in the relationship between an MFI and the

other NGOs, or changes in the internal structure, as well as the mservices, which they offer to clients. The major factors that need to be addressed in building the institutional capacity of MFIs include the following: (a) Good governance Good governan


82

principle, private ownership in combination with an unrestricted profit orientation

th the ultimate sanction of ismissing the board. There are two key points here: First, in a company for-profit,

derstood by senior management, the boar d, the empo to tak e nc tisfa ver, f the MFIs in Ethiop it o n ofte r. Although public m ested ost of the MFIs, there a t clearly d able o of the assets can tak ion whe rforman oor. Mor p ce criteri ese M re ofte poorly ed and difficult to m . This is es lly the case where different st ders who may be re nted on a bo ve dive objectiv Some argue agains ate ow ip of MFIs in Ethiopia stating that although g g credit to p orrowers may turn be a ble bus n a li financial over edium t financia preneurs are likely to market to b profi han sm d micro rise le his might lead them to turn to other s of cu s and thu up the delivery of financ rvices to oor households and alized are T e of govern and o hip in t hiopian seri sue

essed diately. With the exception of one MFI, the holders who share the benefits of the operation of an

responsibility and responsiveness of MFIs to changing environments. Effective governance depends on both forms- the structures and processes of control, and content-and the specific individuals involved, particularly in the leadership. For example, board members are expected to have skills as leaders, visionary thinkers, and managers. They should have independent mind, genuine commitment, technical expertise and experience relevant to manage MFIs (financial, legal, marketing, etc), and willingness to set time to participate in the activities of an MFI. Moreover, although the formal institutional (legal) context determines the broad framework for the governance structure – for example, the roles and responsibilities of directors of MFIs – it rarely appears to play the major role of good governance. Inappears to be the basis for securing an efficient provision of financial services as long as banking supervision functions properly and competition ensures that no single institution is in a position to charge monopolistic prices. In a company for-profit, shareholders own the assets and a board of directors has a fiduciary responsibility to those shareholders for the effective use and protection of those assets. The board’s competency in exercising that fiduciary role can be measured relatively easily in terms of the financial performance of the institution. Where performance is unsatisfactory, owners will be expected to take action, widthere is generally a performance framework which is readily un

d and others. Secon owners of the assets are wered e action wh

ia which areoney is inv

re performa not-for-prof

e is unsarganizatio

ctory. Howes, ownership is

in many on unclea

in m re no efinwners who e act re pe ce is p eover, theerforman a of th FIs a n both defineasure pecia akeholprese ard ha rging es.

t priv nershrantin oor b out to profita iness iberalized system the m erm, l entre find out niches e more table t all an enterpnding. T group stomer s give

ial se the p margin as.

he issu anceaddr

wnersimme

he Et MFIs is a ous iswhich needs to be shareholders are not real share


83

n thiopia are not interested in selling shares and attracting other shareholders. Since

nagement and monitor the performance of MFIs.

comprehensive training need assessment for sub-branches, branches, head office,

eration such as profit haring, collection fees, etc and efficiency wages as compatible) should be

of financial sustainability and increasing outreach. his includes fixed salary plus a bonus or incentive payments that is a function of

MFI. The issue of accountability and fiduciary responsibility is questionable. MFIs iEboard members are predominately NGO staff or government employees, there is a tendency to promote and share the vision and mission of the mother-NGO and government development interventions. The law prohibits foreign organizations and non-Ethiopians in participating as shareholders in the sector. According to the study by Itana et al., (2003), there are no regular board meetings and self-evaluation of boards in many of the MFIs. Moreover, board members have limited knowledge and apacity to support mac

(b) Human resource Microfinance institutions are highly labor intensive. Labor costs, very often, account for more than half of their total cost of administration. A crucial element of an MFI’s capacity therefore depends directly on the effectiveness of its staff. The direct productivity in terms of the size of portfolio and number of clients which can be handled effectively by a front-line loan officer is enormously important for its sustainability. Although productivity depends on many factors, the performance of the individual officer is a major determinant. The ability to train, motivate and effectively manage its lending officers is at the core of its capacity. The capacity building process should involve training and re-training of all staff including the board of directors. Thus, appropriate career development programs, with on-going training and support, are essential ingredients of the business plan of a successful MFI. Aclients and board members of the MFIs was conducted in 2003 with the support of the Rural Financial Intermediation Program (RUFIP). The findings revealed that there is huge gap in terms of staff training needs in the industry to ensure growth and sustainability. The training needs identified in the study are aimed at addressing the challenges of lending methodologies, understanding the community, product development, financing agriculture, saving mobilization, internal control and audit, MIS, financial management, gender sensitization and governance. Detailed training modules and training programs were prepared for various categories of staff (RUFIP and AEMFI, 2003). Moreover, a system of incentives (performance-based remunsintroduced to meet the objectivesTsome observable variable or performance indicators, such as profits or loan installments recovered. However, in the Ethiopian context, although MFIs complain


84

trol system) and enerating the information necessary to mange the portfolio. The availability of

rved to mange information (MIS), at is, primarily on the back end. This has helped MFIs to standardize their

design their business models and educate their employees and customers to

about the high turnover of senior staff, there has not been a concerted effort to address the issue of staff incentives. (c) Systems Effective systems underpin both the efficient implementation of innovative methodologies and the management of an MFI. Significant reduction in transaction costs can be achieved through the use of innovative lending methodologies, ensuring good client service, maintaining the integrity of the operations to ensure accuracy and prevent fraud (through an appropriate internal and external congaccurate, relevant and timely information is essential for both front-line staff and the varying levels of management to be able to take effective actions. Information technology (IT) has a potential role in increasing outreach and improving sustainability of an MFI. Efficiency achieved through the use of information technology has an immediate bearing on transaction costs and potentially rendering new markets or product. Beyond its use in portfolio tracking (the ability to detect and follow-up rapidly on loan defaults) and accounting, IT can also be used to support products directly. Nevertheless, it does not appear that the full computerization of an MFI operation is a prerequisite for the sustainability in all contexts. There are cases in Bangladesh, India, Ethiopia and others, where much of the loan tracking is carried out manually without apparently undermining sustainability. However, it is clear that IT provides better management information which can significantly improve managerial decision making at various levels. Although there are efforts by some MFIs in Ethiopia to apply software such as TMS, Loan Performer, and Emerge to track financial and operational information, there is a need in the industry to address the issue holistically. In the context of Ethiopian MFIs, technology has sethoperations, produce timely and transparent financial reports on their operations and otherwise needed. However, there are huge opportunities where Ethiopian MFIs can use new technologies in the front end. Among the technologies that available to be used in the front end include: magnetic stripe and chip (smart) cards, point of sales devices, ATMs, cell phones, satellite communications, the internet, credit scoring, data mining, biometric recognition and more. These technologies will require MFIs to remaster new ways to deliver and receive services. Such changes will not always be easy, but the benefits will be dramatic.


85

hich involve arket research and new product development. Households are not homogeneous

segments appear with different needs. For example, and rural areas have different financial needs at

ucts; ) huge demand for microfinance services leading to little incentive for MFIs to

ducts and professional skills for their staff in the area of market search, product development and risk management, could limit their capacity to

5.2 Developing demand driven financial products and methodologies

MFIs need to increase their scope and operation by searching for new markets and deepen their penetration by broadening the range of financial services offered to households. We believe that the poor in both the rural and urban areas are lucrative customers worth wooing for MFIs. The microfinance providers should shift from the traditional supply-driven financial products to demand-driven products wmand within one group, different

icro enterprise operators in urban mdifferent times. Using a product development process that is client centered allows meeting both the financial and social goals of an MFI. Focusing on what is of value to the client influences the operational efficiency as well as product design, increases client satisfaction and retention, and profitability of MFIs. Products tailored to client’s financing needs have greater impact in helping them manage the volatility inherent in the sector within which they work. Designing product terms tied to client cash flow also improves the repayment capacity and allows the MFIs to sustain their operation. The major factors which affect product development in the Ethiopian MFIs include: (a) the regulatory framework which restricts MFIs to limited financial prod(b

develop new products or modify existing ones; (c) lack of competition in the industry; (d) donor and government intervention influencing the type of financial products;

and (e) limited technical skill and financial resources to test new products (Wolday,

2002). As indicated earlier, one of the critical issues in product development is the weak capacity of MFIs, MFI’s failure to establish the necessary institutional setup to develop financial proreidentify and respond to changes in the market and limit their growth. There is a consensus in the industry to develop innovative lending methodologies and financial products which match the needs of rural and urban households. Underpinning all methodologies for delivering microfinance services is the need to minimize transaction costs. A wide variety of mechanisms exist but many can be seen to belong to the following three broad categories


86

he solidarity group based lending approach, often associated with the Grameen esh, is an innovative lending methodology which minimizes

ansaction costs (in the process of screening clients). It also addresses the problems

er, will be upported by compulsory savings. This is the dominant lending approach used by

response to the above problems and the needs identified by market research, MFIs

lts, information flow in the community and other ocio-cultural issues. Ethiopian MFIs are recently introducing individual lending

(a) Group lending methodology TBank in Bangladtrof physical collateral requirement of conventional banks through intra-group guarantees and reduces the cost of administration by addressing the loan needs of clients collectively. In order to obtain a loan, members of a group cross guarantee one another’s borrowing, as they would have reliable personal knowledge of their fellow group members. Actually, the group lending methodology is mainly based on peer group pressure (social capital). When a borrower defaults on a loan, the lender will look first to the guarantees from the members of the group. Frequently the cross-guarantees, which members of the group provide towards one anothsalmost all MFIs in Ethiopia. Although the group lending methodology has been a very useful tool in expanding the growth in outreach of MFIs in Ethiopia, clients have complaints on the methodology. (b) Individual lending There is no “one size fits all” approach in microfinance. An MFI can use a combination of various lending methodologies which match with the needs and economic activities of its clients. As indicated earlier, there are complaints on the group lending methodology in Ethiopia, for instance, why should clients be penalized for a colleague who defaulted, it excludes the poorest households, it encounters difficulties as the size of the loan increases and does not necessarily fit to the needs of MSE operators and others who need relatively larger loan size, etc. Inhave been developing individual lending methodologies based on traditional and non-traditional collateral. Non-traditional collateral includes household and business assets such as radio, TV, bicycle, sewing machine, etc. The conventional approach used by commercial banks to screen borrowing proposals, based on analysis of historical performance and business plans are usually inappropriate for microfinance. Clients of MFIs hardly keep reliable records and are unable to produce meaningful business plans. The efficacy of the individual lending methodology depends on various factors such as strength of the legal system in enforcing contracts, the ability of an MFI to enforce the lending agreements in the case of defaus


87

Birr). So ve also reduced the group size from five to three.

) Community based or user-owned/managed lending

to nsure sustainability.

crrb

its ability to meet its liabilities. Securing appropriate investment capital for growth of utreac s not merely a question of the availability of funds, but the form of

methodology to provide loans to MSE operators who require larger loans (above 5,000 me MFIs such as DECSI ha

(c There is a very significant potential for lowering transaction costs through financial organizations which are both owned and managed by communities. These include the Savings and Credit Cooperatives (SACCOs), Credit Unions, Village banks, Rotating Savings and Credit Cooperatives (ROSCAs), burial societies, etc. Such organizations are able to draw directly on both local knowledge about borrowers and social capital to reduce the transaction costs and the associated risk. Since the above organizations are locally owned, the potential loss of social capital in the event of default can represent a powerful disincentive to default. Transaction costs associated with the administration of financial products are reduced due to the geographic proximity of the organization to its clients and the lower labor costs by using local staff or members themselves. While member-owned institutions are prevalent in many rural and urban areas, including remote areas, and serve poorer segments of the population in Ethiopia, they have limitations in becoming the prime financial intermediaries. Since they are self-managed, an appropriate form of governance needs to be developed for each type e 5.3 Mobilizing loanable funds Significant investment capital is needed to develop new or moving existing institutions to in ease outreach. The balance sheet of an MFI must have sufficient strength to abso losses which can arise within long-term business cycles, without threatening

h of MFIs iofunding. The loanable funds of MFIs in Ethiopia are primarily from six sources: (a) Mobilizing savings: Ethiopian MFIs have proved that the poor have a high

propensity to save when provided with safe, accessible and convenient mechanisms. Access to saving facilities is as important as credit for the poor. Moreover, it increases the autonomy of an MFI and is one of the reliable funding sources for MFIs to finance growth and expansion. Thus, MFIs should develop business plans that would allow them to capture savings from clients and non-clients.


88

Eq e in microfinance activities, MFIs in Ethiopia are required to have a minimum of 200,000 Birr (23,000 USD) as paid-up

rate. RUFIP has been very successful in providing loanable fund, build capacity, promoting growth of their activities, improving

atory framework. ) Donation: MFIs have been obtaining donations and grants as seed money

ansion of the operations of MFIs would require outside sources of funding.

try commerce, etc), the performance of the financial sector policies,

(b) uity: To get license and operat

capital. The equity investment of MFIs is very limited. There are very limited initiatives to sell equity and increase their loanable fund.

(c) Loan from formal banks: Although over liquid, the formal banks in Ethiopia were not interested in lending to MFIs. On the other hand, due to the sweet money obtained from donors, MFIs in Ethiopia were initially reluctant to access loan from banks at market rate. However, recently some MFIs have shown keen interest to take loan from banks through the support of regional governments, NGOs and donors by introducing credit guarantee schemes.

(d) Rural Financial Intermediation Program (RUFIP): This particular program is financed by IFAD, ADB and the Ethiopian government to support MFIs and Saving and Credit Cooperatives (SACCOs). Out of the total fund of the program (87 million USD), 81% is allocated for loanable fund, for MFIs and rural SACCOs, and the remaining 19% for capacity building. Those MFIs, which ful-fill the minimum performance requirements of the program, are eligible to take loan at 6% lending interest

efficiency, and enforcing the regul(e

(start-up capital) or funds for expansion from their mother NGOs. However, many of the MFIs are realizing that funding sources from NGOs and donors are becoming scarce.

(f) Income from lending activities: Although some MFIs are currently expanding their activities from own income, the interest income and fees from lending activities or operations of many MFIs in Ethiopia were not large enough to cover operational costs and finance expansions. Thus, a significant exp

5.4 Enabling policy, legal and regulatory environment An enabling policy environment is important to achieve substantial outreach and attain operational and financial sustainability of MFIs. The sectoral and development policies, the commitment of governments at various levels, the performance of the macro economy (the state of the real economy related to improving the efficiency in agriculture, industhe efficiency of the legal and regulatory system, fiscal and monetary system, and political system affects the growth of outreach of MFIs.


89

s ynamism is expected to result in high and growing demand for financial services.

the growth of MFIs. owever, macroeconomic stability, although important, is not by itself, a sufficient

ote the industry, should have a clear microfinance strategy hich will be reflected in all the development and sectoral policies. In the Ethiopian

licies has also a direct influence on the success of microfinance ctivities measured in terms of outreach, productivity, efficiency and sustainability. As

ia has implemented the Rural Financial termediation Program (RUFIP) by taking a loan of 87 million USD from IFAD and

ty of

positdirecacco(Wolin Etof the (NBE) and senior staff to discuss the problems of the microfinan stry.

It is argued that a dynamic economy and comparatively stable macroeconomic and political environment offers an enabling climate to the success of the MFIs. ThidStable macroeconomic conditions and low inflation do supportHcondition. There are poorly performing MFIs in countries with stable macro economic conditions. If we take the example of DECSI, although the region where this MFI is operating is one of the poorest regions (with stagnant economy) in Ethiopia, its performance in the last ten years has been remarkable by all standards. This is partly due to political commitment, political stability, high degree of social cohesion and traditional social structures that facilitated the enforcement of contracts, increase outreach and efficiency. The various policies and the commitment of the governments at various levels to support microfinance activities have direct impact on outreach and viability of MFIs. The government, to promwcontext, the government is committed to promote the delivery of microfinance services to poor households. Microfinance is considered by government as its own tool to fight poverty. This is reflected in the poverty reduction program, food security strategy, rural development program, industrial policy, etc. The effectiveness of the monitory and fiscal poaindicated earlier, the government of EthiopInADB to support the microfinance activities. This shows the real commitment of the government to promote the industry. However, although the microfinance industry needs the support of the government at various levels, this does not mean that it should involve directly in the delivery of financial services to the poor. Actually, in the Ethiopian context, this is prohibited by law.

egulatory environment affects growth, efficiency, productivity and sustainabiliRMFIs. The regulatory framework of microfinance institutions in Ethiopia has played a

ive role in increasing outreach and mobilizing public saving. However, the tives and the microfinance legislation (40/96) in Ethiopia need to be revised to mmodate the dynamic growth and innovations in the microfinance industry day, 2005). On the other hand, there are positive and encouraging developments hiopia, where the general managers of all MFIs regularly meet with the governor National Bank of Ethiopia

ce indu


90

foreclpropewoul ssociation of Ethiopian

revisweakfocus 5.5

The loanatraini(iii) athat m It is c

,

formavolum

oMicrothereinclu

an nks, they are not llowed to pay the interest and the principal in hard currency. Since these restrictions

gulatory amework. On the other hand, although donors can play a positive role in increasing

The legal framework in Ethiopia is very weak in enforcing loan contracts. Without the osure legislation (which gave power to commercial banks to foreclose the rty of a borrower in 30 days, if he/she defaults), the banking sector in Ethiopia

d have collapsed long ago. MFIs, through their network, AMicrofinance Institutions (AEMFI), have requested the National Bank of Ethiopia to

it and amend the foreclosure legislation to include both banks and MFIs. The legal environment has discouraged MFIs from developing financial products ing on individual lending methodology.

Donor support

support of donors to MFIs takes mainly four dimensions, namely, (i) provision of ble capital as grant, soft loan, etc, (ii) building the capacity of MFIs by providing ng, computers, office equipment, vehicles, MIS, communication equipment, etc, dvisory services, and (iv)contribute in developing and piloting innovate products eet the needs of poor households.

lear that MFIs need seed money in the first year and soft loans in the second however, in the third year; the MFI should access loyear ans at market interest rate.

When financial self-sufficiency is attained, the institution should be transformed into a l financial institution which is characterized by a marked increase in portfolio e, productivity and a concomitant decline in average lending costs.

Don rs in Ethiopia have been supporting almost all MFIs (with the exception of Agar

finance Institution) in building their capacity. Unlike many African countries, are restrictions on the interventions of donors in the microfinance industry which de: (a) MFIs should be owned by Ethiopians, (b) donors cannot be shareholders MFI, and (c) if MFIs access loans from donors or foreign bain

ahave direct impact on the growth of MFIs, we need to revisit the refroutreach and efficiency of MFIs, they could also distort the financial markets by injecting subsidized funds in the system. The MFIs in Ethiopia complain that some donors such as the World Bank are distorting the financial markets through its food security program.


91

onstraint. Government institutions at various levels, donors,

ht and others, irregular cash flows, ifficult terrain, remote and illiterate clients, highly diversity, and sparse population.

tween 2001 and 2005, the number of clients, volume of loan ortfolio and savings increased by 263%, 479%, and 206%, respectively.

5.6 Demand side Growth in outreach of MFIs is affected by factors affecting the efficiency and productivity of active and potential clients. The education and skill of potential clients; availability of markets and working places; and growth and performance of the real sector affects the growth, portfolio quality, efficiency and productivity of MFIs. According to Geberhiwot and Wolday (2004), the most important constraints of micro and small enterprise operators were mainly related to access to markets and finance. Among the top three problems experienced in starting up their business were capital constraint, inadequate premise, demand shortage and inadequate skill. About 72 percent of the micro and 65 percent of the small enterprise operators reported lack of markets as their major cNGOs and other development partners should play a key role in addressing the demand side problems of clients. Governments at various levels, NGOs and other development partners should also play an active role in providing non-financial services such as Business Development Services (BDS). The results of the study by Wolday and Geberhiwot (2004) indicated that there were very few BDS providers offering limited services to few MSE operators (very low outreach). MSE operators had very limited vocational and technical training (before starting business), received few short-term training, extension and counseling, and marketing services.

6. Conclusion recommendations Many of the MFIs in Ethiopia have been focusing on addressing rural poverty. As rural finance providers for poor households in remote areas, MFIs have been dealing with seasonality issues, high covariant risk, low average returns, inadequate information infrastructure, large risks due to drougdThe performance of MFIs, in Ethiopia, be it in terms of outreach or sustainability, should be evaluated against this tough environment. As of June 2005, the twenty six microfinance institutions registered under the National Bank of Ethiopia had an active loan portfolio of about 1.5 billion Birr (173 million USD) delivered to 1,211,305 active clients. They mobilized about 501million Birr (58 million US dollars) of savings. The clientele served by the MFIs in Ethiopia are mainly the rural poor. The Ethiopian MFIs have attained significant outreach in a brief period of time. Bep


92

he 15 MFIs, eleven had less than 5% ortfolio at risk, which was encouraging. Out of the 13 MFIs which registered

ca , 9 showed a remarkable decline in their portfolio at risk. s a result of increased outreach, many of the MFIs maintained and improved their

and provide the broad range of

of financial

l products, and an increase of geographic expansion; (ii) creating n enabling legal, regulatory and policy environment; (iii) selective donor support; and v) improving the demand side of the equation.

A large number of MFIs in Ethiopia have achieved significant progress in terms of sustainability. In 2004, 12 out of the 15 MFIs were operationally sustainable, while 5 were financially sustainable. There was a substantial growth in outreach and improvement of operational and financial sustainability within one year (2003-2004). There was also a consistent decline in operating expense to loan portfolio ratio as a result of significant increase in outreach. The majority of the MFIs increased their productivity indicators (borrower per staff and borrower per loan officer) as a result of expansion or increase in outreach. Out of tpsignifi nt growth in outreachAportfolio quality. The prospect for growth of MFIs in Ethiopia is bright, particularly when growth promoting forces are put on the ground and when microfinance institutions are allowed to do what finance is supposed to do. The whole objective of microfinance hould be on developing institutions that can creates

microfinance services that will support millions of poor people in their efforts to improve their own and their children's prospects. This is realized through development of capable and sustainable MFIs. Efforts should be made to increase the efficiency of MFIs financially. They should also be made organizationally stable and more professional in order to be able to deliver financial services to millions of

nbanked people permanently. This should also include the provision uservices to pastoralist areas that currently have little or no access to microfinance services. Managing and planning growth of MFIs in Ethiopia will require deliberate actions and strategies designed by policy makers and industry leaders. This requires careful balancing of increasing outreach and sustainability; with a parallel focus on institutional capacity; reducing costs and risks; and improving efficiency, profitability and portfolio quality. The specific interventions to increase the growth of MFIs include: (i) improving the institutional capacity of the MFIs by introducing an efficient organizational structure, (changes in organization culture, structure and systems, for instance, decentralized lending decisions) with appropriate staff incentive and reward system, improved skill of human resource, good governance, introduction of innovative financiaa(i


93

and Mesfin Nemera (1996) Ethiopia: rural credit center for economic growth. Credit Financial Sector Development Project II (FSDP II)

iopian MFIs. AEMFI. Bulletin No.1 olday Amha (2002) Product development in the Ethiopian microfinance industry: Challenges

y enges and the role in poverty reduction. AEMFI. Occasional Paper No. 7.

References ACDI/CEE (1995). Ethiopia: Rural finance and micro-enterprise needs assessment,

Washington D.C and Addis Ababa

Bezabih Emana, Kejela Gemtessa, Dhunfa Lemessa, and Gezahegn Ayele (2005) Informal finance in Ethiopia. Association of Ethiopian Microfinance Institutions (AEMFI). Addis Ababa.

Gebrehiwot Ageba and Wolday Amha (2004) Micro and small enterprise (MSE) finance: A survey experience. Proceedings of the International Conference on Microfinance Development in Ethiopia. Awassa.

Itana Ayana, Tsehay Tsegaye and Eshetu Erena (2003) Governance and ownership structure of microfinance institutions in Ethiopia. AEMFI. Occasional Paper No.8

Krahnen J.P and Schmidt R.H (1994) Development Finance as Institution Building. Westview Press, Boulder.

Pischke J.D, Itana Ayana. Edward L.N

RUFIP and AEMFI (2003) Training need assessment of microfinance industry in Ethiopia. AEMFI. Occasional Paper No. 9

Schmidt R.H and Zeitinger C.P (1996) Prospects, problems and potential of credit-granting NGOs. Journal of International Development. Vol. 6, No. 2.

Stigltz J. E (1989) The economics of rural organization: Theory, practice, and policy. Oxford University Press. Oxford.

Tsegaye Anebo (2005) Performance analysis report for EthW

and Prospects. AEMFI. Occasional Paper 4. Wolda Amha (2003) Microfinance in Ethiopia: Performance, chall

Wolday Amha (2005) Prudential regulation of the microfinance industry: Lessons from Ethiopia. AEMFI. Occasional Paper No. 15

Wolday Amha and Gebrehiwot Ageba (2004) Business Development Services (BDS) in Ethiopia: Status, Prospects and Challenges in the Micro and Small Enterprise Sector. A paper presented on the fourth international conference in microfinance development in Ethiopia. Awassa

Yaron J. (1992) Successful rural finance institutions, Discussion Paper No. 150. Washington D.C, World Bank


94

Annex 1: Amhara Credit & Savings Institution

Indicators 2004 2003

Outreach

Number of Active Borrowers 351,163 288,681

Gross Loan Portfolio 308,934,727 206,745,388

Savings Balance 172,797,599 128,649,147

Profitability

Operational Self-Sufficiency 231.8% 178.4%

Financial Self-Sufficiency 156.0% 137.0%

Efficiency

Operating Expense/ Loan Portfolio 6.2% 7.6%

Personnel Expense/ Loan Portfolio 4.2% 5.3%

Productivity

Borrowers per Staff Member 210 195

Borrowers per Loan Officer 335 293

Portfolio Quality

Portfolio at Risk> 30 Days 0.5% 1.7%

Write-off Ratio 1.5% 2.2%

Annex 2: Addis credit & savings institution


Outreach



7.8%


Savings Balance 6,215,161 2,982,394

Profitability



Efficiency



Productivity



Portfolio Quality

Portfolio at Risk> 30 Days 20.6%


95

age financial services


Annex 3: Africa vill

Outreach

Number o 2,866

Savings B

Profitabi

Financial

Producti

Borrower

Portfolio a 2.3% 11.6%

f Active Borrowers 4,867


alance 1,077,809 658,421

lity


Self-Sufficiency 63.1% 64.9%

Efficiency



vity


s per Loan Officer 304 239

Portfolio Quality

t Risk> 30 Days


: Bussa Gonofa MFI Annex 4Indicators 2004 2003

Outreach


an Portfolio 2,116,415 Gross Lo 2,133,046

Financial

Efficienc

Personne folio 21.9% 21.6%

Productivity



Portfolio Quality



Savings Balance 749,178 458,880

lity Profitabi


Self-Sufficiency 80.2% 86.6%

y


l Expense/ Loan Port


96

Annex 5: Dedebit Credit & Savings Institution Indicators 2004 2003

O utreach

N 6

G 8

S 0

P

O

F

E

O

P

P

B 6

B 5

P

P

W

umber of Active Borrowers 336,733 225,99

ross Loan Portfolio 377,726,250 186,012,79

avings Balance 153,776,824 131,346,54

rofitability

perational Self-Sufficiency 215.5% 180.4%

inancial Self-Sufficiency 125.3% 95.7%

fficiency

perating Expense/ Loan Portfolio 3.8% 6.1%

ersonnel Expense/ Loan Portfolio 2.3% 3.7%

roductivity

orrowers per Staff Member 388 33

orrowers per Loan Officer 1,840 1,34

ortfolio Quality

ortfolio at Risk> 30 Days 2.3% 6.2%

rite-off Ratio 7.1% 12.4%

Annex 6: Eshet Microfinance Institution


O utreach

N 0

G 1

S 6

P

O

F 1

E

O 1

P

P

B 2

B 6

P

P

W

umber of Active Borrowers 9,728 6,54

ross Loan Portfolio 7,343,034 3,826,46

avings Balance 850,800 456,59

rofitability

perational Self-Sufficiency 155.0% 103.8%

inancial Self-Sufficiency 19.7% 80.8%

fficiency

perating Expense/ Loan Portfolio 4.7% 24.7%

ersonnel Expense/ Loan Portfolio 8.6% 14.3%

roductivity

orrowers per Staff Member 191 15

orrowers per Loan Officer 278 22

ortfolio Quality

ortfolio at Risk> 30 Days 0.9% 0.1%

rite-off Ratio 0.0% 0.1%


97

Annex 7: Gasha Microfinance institution

Indicators 2004 2003 Outreach

Number of Active Borrowers 8,121

6,423



Profitability



Efficiency



Productivity



Portfolio Quality



Annex 8: Meklit Microfinance Institution

Indicators 2004 2003Outreach


Staff Member 146 163

Days 17.7% 9.7%

3,577



Profitability



Efficiency


Personnel Expense/ Loan Portfolio

Productivity

8.6% 8.8%

Borrowers per


Portfolio Quality

Portfolio at Risk> 30



98

Annex 9: OMO Microfinance Institution


Number of Active Borrowers 75,439 0

5

8

9

2

70,59


Savings Balance 25,969,672 20,882,51

Profitability



Efficiency



Productivity



Portfolio Quality



Annex 10: Oromia Credit & Savings s.c


Number of Active Borrowers 86,998 0

5 2

8 7

% %

% %

% %

% %

5 3

8 6

% %

% %

62,15



Profitability

Operational Self-Sufficiency 152.3 94.9

Financial Self-Sufficiency 94.8 64.4

Efficiency

Operating Expense/ Loan Portfolio 9.0 10.8

Personnel Expense/ Loan Portfolio 5.4 6.2

Productivity


Borrowers per Loan Officer 1,20 25

Portfolio Quality

Portfolio at Risk> 30 Days 5.0 7.8

Write-off Ratio 0.0 0.0


99

ity Empowerment 4

Annex 11: Poverty Eradication & CommunIndicators 200 2003

Outreach Number of Active Borrowers 7,766 5,428

Gross Loan Portfolio 7,696,972

6

7

8

5,192,843


Profitability



Efficiency



Productivity



Portfolio Quality

Portfolio at Risk> 30 Days 0.1% 0.2%Write-off Ratio 0.0% 0.0%

Annex 12: Sidama Microfinance Institution

4 Indicators 200 2003

Outreach


4

0

%

%

%

%

89

> 30 Days %


11,346



Profitability

Operational Self-Sufficiency 83.1 57.2%

Financial Self-Sufficiency 50.8 36.6%

Efficiency

Operating Expense/ Loan Portfolio 16.4 19.2%

Personnel Expense/ Loan Portfolio 8.6 10.2%

Productivity

Borrowers per Staff Member 98

291 Borrowers per Loan Officer 267

Portfolio Quality

Portfolio at Risk 26.2 29.2%


100

otional Institution

Annex 13: Specialized Financial & PromIndicators 2004 2003

Outreach


1

1

9,552



Profitability



Efficiency



Productivity



Portfolio Quality



Annex 14: Wasasa Microfinance Institution


Outreach


13

10

1

10

1

2

5

1.2%

3,728


Savings Balance 1,475,239 577,488

Profitability



Efficiency


Personnel Expense/ Loan Portfolio 11.3% .3%

Productivity



Portfolio Quality

Portfolio at Risk> 30 Days 0.1% .9%

Write-off Ratio 4.5%


101

Ind 2004 200Annex 15: Wisdom Microfinance Institution

icators 3 Outreach


18,71 11,6

5,63 4,0

115. 88

88. 78

19.9 20

9.9% 8.8

133 12

262 32

3.5% 5.3

5.6% 6.9%

2 51

Gross Loan Portfolio 0,578 26,351

Savings Balance 3,654 43,453

Profitability

Operational Self-Sufficiency 5% .6%

Financial Self-Sufficiency 0% .8%

Efficiency

Operating Expense/ Loan Portfolio % .8%

Personnel Expense/ Loan Portfolio %

Productivity

Borrowers per Staff Member 0

Borrowers per Loan Officer 0

Portfolio Quality

Portfolio at Risk> 30 Days %

Write-off Ratio

manag ing growth of microfinance institutions (mfis

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